FX BEAT: ‘Good Times’ AUD can prosper from China rebound

Signs that China’s economic rebound is gaining momentum, improving the outlook for commodity prices, can help the Australian dollar strengthen over the remainder of the year, according to Westpac senior currency strategist Sean Callow. 

The Aussie was buffeted in the first quarter by financial sector turmoil, triggered by the collapse of Silicon Valley Bank in March, which stoked concerns over the outlook for the global economy. 

“The Aussie is often seen as a ‘good times’ currency. It outperforms when the global economy is accelerating and it underperforms in times of global stress,” says Callow in a podcast interview with Westpac Wire.
 

The currency dropped below 66 cents to the US dollar in March, having started the year north of the 70 cent level. It has since settled in to a range broadly between 66-68 cents, and Callow’s team are sticking with their forecast for a year-end rate of around 74 cents. 

He notes that the Aussie tumbled from close to parity against the US currency to 60 cents in just a few months at the height of the global financial crisis in 2008, but by late 2009 had already recovered back above 90 cents. 

“It can move very quickly when the mood changes. A lot of it comes down to that leverage to growth, and particularly to Asian growth and demand for commodities, and that obviously helps Australia's trade position as a commodity exporter.”  

China’s economy grew by 4.5 per cent in the first quarter of 2023, beating most economists’ expectations, while the latest trade and industrial production numbers from Asia’s largest economy have also come in strong. 

“We saw particular strength in steel production, so that's encouraging for Australia’s iron ore exports,” Callow says. Prices for iron ore, Australia’s top commodity export earner, remain at levels which are highly profitable for Australian miners, he added. 

Australia continues to run a healthy trade surplus, and that’s an important buttress of support for the Aussie dollar. 

Even so, it’s interest rate differentials that are the primary driver of global currency markets, and the signals for the Aussie on that front are more mixed.

Westpac economists expect one more interest rate increase from the Reserve Bank, taking the cash rate to a peak of 3.85 per cent, while they think the Federal Reserve has completed its tightening cycle with the fed funds rate at 4.75 to 5 per cent. 

However, Callow notes that markets are leaning towards one more Fed rate hike, and as long as Australia’s short-term yields continue to track below those in the US, that would act as a headwind for the Aussie dollar.  

The British pound has made up some ground against the Aussie this year, after the Bank of England was forced to ratchet up interest rates to get runaway inflation under control. But Callow believes the rally may run out of steam in the months ahead.  

“Markets are pricing the cash rate in the UK to rise from 4.25 per cent to 4.9 per cent or thereabouts over the course of this year. That's definitely a yield advantage for sterling. But with Australia's leverage to China, and that strong trade position for the Aussie dollar, we think that eventually does start to support the Aussie.”

Callow sees scope for the Aussie to firm to around 58 pence per A$ in the second half of the year, from around 54 pence currently.

Likewise, aggressive interest rate hikes from the Reserve Bank of New Zealand have given the NZ dollar an advantage over the Aussie, with NZ’s cash rate of 5.25 per cent one of the highest among developed world economies. 

“That's been a big support for the NZ dollar, except that they're openly talking about needing to go through a recession to lower inflation.” 

Ultimately, that could force the RBNZ to start cutting rates within the next 12 months, while the Australian economy is in relatively better shape. 

Along with perceptions that Australia will benefit more than New Zealand from China’s economic recovery, it could be that the Aussie dollar regains some ground over its trans-Tasman neighbour in the months ahead.